Most companies go through cost takeout exercises as a matter of routine. The basic move is to review unproductive or out-of-market costs and create a set of remediations to shed some of them. Typically, there is a rhythm to this kind of thing, allowing organizations to adapt to times of abundance and to times of austerity.
The practice of periodic cost-out is healthy as costs tend to accumulate and not go away on their own. Like cleaning out the pantry from time to time, companies need to remove costs associated with technology, capabilities and facilities that are no longer required or that can be terminated, phased out or potentially resold or monetized. Many of these costs are associated with decisions made to address needs and priorities that have subsequently changed. And many costs grow unchecked over time unless scrutinized for potential adjustment, renegotiation or resourcing.
Undertaking these traditional cost-out measures is a critical element of business hygiene. But, in general, this approach tends to be linear and episodic, the result of a somewhat static and siloed view of costs. It asks questions like “how can we reduce the rising cost of the cloud – or the network, or software, or labor or energy?” Thinking about costs or “spend” in categories is useful as an organizational principle, but it can also limit how a company thinks about the cost problem and, therefore, the range of solutions that are brought to bear.
Traditional cost takeout exercises often still leave companies with rising costs. Many solve cost problems by negotiating better unit prices or fixed fees for a carefully defined scope, but then very quickly find their needs and circumstances have shifted, and the solution they put in place no longer matches the environment. Traditional cost takeout was developed for relatively stable environments and is ill suited to the dynamic pace of change of today’s digital business world.
Typically, technical requirements and volume forecasts are developed by one team, negotiated and contracted by a second and executed by a third. Often, the effect is “fire and forget” as the first team moves on to the next initiative, and there is no real feedback that enables productive adjustment to rapidly changing variables. Cloud spend is a perfect example. Companies negotiate competitive discounts with hyperscalers, but, in pursuit of these discounts, they often commit to greater volume than they need. The result is good pricing but significant excess cost – sometimes more than double the cost of a truly optimized environment.
A new approach to optimizing costs
Traditional levers of spend aggregation, economies of scale and fixed requirements can be ineffective, and in some cases, counterproductive to achieving cost optimization. Often, these practices hinder the flexibility of the enterprise.
Managing costs at the speed of digital requires a shift in thinking from long-term fixed commitments to long-term strategic relationships. It requires a deliberate effort to preserve options and provide constant updates to the ecosystem. This means organizations must constantly sense, analyze and respond to operational and cost data across functions in a way that incorporate the business, technology, sourcing/vendor management, data science and finance. Numerous disciplines need to be at play – including cloud FinOps, Technology Business Management (TBM), software asset management (SAM), concurrent transportation management (CTM) – to create persistent transparency, accuracy, analysis, feedback and communication across the enterprise and its external partners.
Additionally, companies must move beyond optimizing specific categories of cost in a silo, and instead pursue strategies that recognize that lower costs in one category can replace higher ones in another. Take our cloud example. Increasing cloud spend can represent a dramatic cost savings provided that, it is efficiently deployed, and the company is able to shed the costs of the more expensive “on-premise” technology that the cloud is replacing. In fact, many of the best cost-saving opportunities come in the form of substitution. Software can replace the need for some physical facilities as well as travel and transportation. RPA increases the productivity of the workforce and reduces the escalation of labor costs. Analytics tools can reduce the cost of sales, customer care and operations.
While traditional cost savings approaches tend to look at each category separately, holistic cost savings approaches take a broader view of the problem, and typically result in a dramatic reset of the entire cost structure. This “substitution-transformation” approach is not the metric most often pursued by corporate procurement for year-over-year cost savings, but it tends to have a much larger impact on costs overall.
Achieving breakthrough cost optimization
Many organizations look at legacy operations for cost takeout to fund new investments but lack the means to optimize the new costs of transformation as that transformation occurs. We estimate that typical digital business transformation initiatives can be accomplished for 30-40% less than the cost achieved through traditional approaches. This is accomplished by techniques such as applying independent project estimation, interdependency analyses, transformation governance and value realization frameworks that also leverage many of the levers outlined above.
The bottom line is that breakthrough cost optimization is readily achievable, but it requires a new generation of techniques that improve upon and sometimes fully replace the cost optimization techniques of the past. ISG helps companies shed costs and transform at the same time, so they are prepared for whatever circumstances the changing economy may bring. Contact us to learn more.